Backdoor Roth conversion and confusion

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boglemtgt
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Backdoor Roth conversion and confusion

Post by boglemtgt »

Hello Bogleheads:
I have two traditional IRA CDs taken with credit union 10-15 years back. They have been renewed over years and now are set to mature in 2026. Now I am contributing 6K for 2020 and 6K for 2021 to Fidelity traditional IRA. I was wondering if I convert 2020,20201 to ROTH IRA, will my credit uniton traditional IRA certificates interfere with my plan for ROTH conversion of the traditional IRA accounts for 2020,2021? Please note these IRA traditional IRAs were opened 10-15years back and are getting renewed.
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I reached out to Fidelity with the exact question and they indicated - I could go ahead . Even with maturity and reinvesting this does not affect your ability to contribute nor to convert as the instruments are investments inside of your IRA.
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But on this forum some threads say there can be NO Traditional IRA. Does my OLD CU TIRA CDs from 10-15 years need to be accouted in the year 2020 contributions ? or since that OLD CDs are alread in IRA accoutn and need not be accounted since these are from 10-15 years back.Given the above situation what is that I can do.
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David Jay
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Re: Backdoor Roth conversion and confusion

Post by David Jay »

Welcome to the forum!

One can always convert as much as they want from traditional IRA (tIRA) to Roth as often as they want. The difference that you are reading about revolves around non-deductible contributions to a tIRA and how much of the Roth conversion will be taxable.

If all of your tIRA contributions have been deductible (you have claimed a tax deduction on your taxes each year for the entire amount of the contribution) then there is no issue. All Roth conversions will be 100% taxed as regular income in the calendar year of the conversion.

If you have made any non-deductible contributions to a tIRA and then decide to do a Roth conversion, the IRS will treat all tIRA funds (including those CDs) as one big “pot” and the taxes will be pro-rated based upon how much of the pot is non-deductible contributions and how much is deductible contributions.
Last edited by David Jay on Fri May 14, 2021 2:27 pm, edited 1 time in total.
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retiredjg
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Re: Backdoor Roth conversion and confusion

Post by retiredjg »

Welcome to the forum :happy

It depends on whether you have or will have any "basis" (already taxed money) in any IRA before you do the Roth conversion.

If your 2020 and 2021 contributions are deductible, the other IRA at the credit union will not interfere with your Roth conversion.

However, if the 2020 and 2021 contributions are non-deductible, you can do the Roth conversion if you want...but it will be pro-rated with the credit union IRA. Many people like to avoid this.
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boglemtgt
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Re: Backdoor Roth conversion and confusion

Post by boglemtgt »

Thank you.
Given that my aim is to convert my non-deductable contributions to TIRA for 2020,2021 to backdoor ROTH IRA, could you please suggest what are my options for the old IRA CDs which is not huge amount but around 5k?
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retiredjg
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Re: Backdoor Roth conversion and confusion

Post by retiredjg »

You only have 3 choices that I can think of.

1. Convert the old IRA to Roth and pay tax on that $5k. And convert the two new contributions to Roth.

2. Don't convert the old IRA and do convert the new contributions - and pro-rate the conversion. I don't suggest this.

3. Transfer the old IRA to a 401k or similar plan so that it is no longer in tIRA to avoid the pro-rating.

In my opinion, option #1 is a no brainer.

I guess there is a 4th option - have your 2020 and 2021 contributions returned to you as if they never happened and don't use the backdoor method to contribute to Roth IRA.
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David Jay
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Re: Backdoor Roth conversion and confusion

Post by David Jay »

boglemtgt wrote: Fri May 14, 2021 2:45 pm Given that my aim is to convert my non-deductable contributions to TIRA for 2020,2021 to backdoor ROTH IRA, could you please suggest what are my options for the old IRA CDs which is not huge amount but around 5k?
Can you convert them to Roth at the Credit Union, without withdrawal? This is the route I would take if it is available at the CU. You will have to pay tax on the amount, but even in a very high tax bracket the tax on $5000 is only a couple of thousand dollars. And the problem is solved permanently without waiting for 2026.

Second, if they will not allow a Roth conversion, what is the early withdrawal penalty? If it is modest, pay the penalty, roll-over the money to your tIRA (the one with the non-deductible contributions) and convert it all to Roth. You will only be taxed on the proceeds of the CDs (and any tiny amount of growth on your 2020 and 2021 contributions while they wait for the CD redemption and roll-over). This clears everything out for future years.
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celia
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Re: Backdoor Roth conversion and confusion

Post by celia »

Before you do anything, you should read our Backdoor Roth wiki page, paying particular attention to the pro rata rule. Once you have any traditional IRA with both pre-tax money and basis (non-deductible contributions) left in any IRA at the end of a year, the pro rata rule will apply every year until all the IRAs are emptied out. It is one thing to have to pro-rate your Roth conversion taxes for a year or two, but a pain to have to do it every year. Luckily, your CDs are small, that it would be simplest to clean everything up by converting all of it to Roth in the same year.

And while I'm at it, the Roth should not have a CD in it. It should be invested in assets that are expected to grow the most (stock funds or stock ETFs) in order to maximized future tax-free growth.

And I'm glad you mentioned that you had more than one IRA CD. You should know that the IRS only allows one indirect rollover of an IRA every 365 days. So only do a rollover if you can make it be a direct rollover, meaning the withdrawal check is made out to the new custodian (For Benefit Of <boglemtgt> or FBO <boglemtgt>). If the check is made out to you, allowing you to deposit it in your personal checking account, that will be an indirect rollover, which prevents you from doing another indirect rollover for 365 days. Banks are not as familiar with this as they don't do rollovers as much as brokerage firms do.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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boglemtgt
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Re: Backdoor Roth conversion and confusion

Post by boglemtgt »

Thank u all for the responses.
retiredjg wrote: Fri May 14, 2021 3:09 pm You only have 3 choices that I can think of.

1. Convert the old IRA to Roth and pay tax on that $5k. And convert the two new contributions to Roth.

2. Don't convert the old IRA and do convert the new contributions - and pro-rate the conversion. I don't suggest this.

3. Transfer the old IRA to a 401k or similar plan so that it is no longer in tIRA to avoid the pro-rating.

In my opinion, option #1 is a no brainer.

I guess there is a 4th option - have your 2020 and 2021 contributions returned to you as if they never happened and don't use the backdoor method to contribute to Roth IRA.
I just talked to CU and they told they may convert it to ROTH but did not confirm yet and I need to check with the IRA processing team Monday.
Assuming option #1 works out and CU agrees to change to ROTH IRA, following are the steps I can think of. Please confirm if this is right.
1. Request CU to convert the TIRA CDs to ROTH IRA on Monday . Ask them for the tax implications. I am assuming I would have to pay tax on this based on the tax bracket in 2021.
2. I have already set up TIRA with Fidelity and transferred funds for 2020 and 2021.
3. Once CU TIRAs are converted ROTH IRA, wait a week for confirmation from CU and then ask Fidelity to convert TIRAs for 2020 and 2021. I am assuming this can be done after Monday Tax due date.

Can you please confirm if the above steps to make my TIRA foot print to zero works? Thanks again.
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retiredjg
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Re: Backdoor Roth conversion and confusion

Post by retiredjg »

I just talked to CU and they told they may convert it to ROTH but did not confirm yet and I need to check with the IRA processing team Monday.
Assuming option #1 works out and CU agrees to change to ROTH IRA, following are the steps I can think of. Please confirm if this is right.
1. Request CU to convert the TIRA CDs to ROTH IRA on Monday . Ask them for the tax implications. I am assuming I would have to pay tax on this based on the tax bracket in 2021.
The tax implication is that about $5k will be added to your taxable income for 2021.

2. I have already set up TIRA with Fidelity and transferred funds for 2020 and 2021.
3. Once CU TIRAs are converted ROTH IRA, wait a week for confirmation from CU and then ask Fidelity to convert TIRAs for 2020 and 2021. I am assuming this can be done after Monday Tax due date.
This works. the order is not really important if you are able to convert the CU IRA to Roth IRA.

Can you please confirm if the above steps to make my TIRA foot print to zero works? Thanks again.
Yes. Unless you do something like roll a 401k into a rollover IRA later in the year.
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boglemtgt
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Re: Backdoor Roth conversion and confusion

Post by boglemtgt »

boglemtgt wrote: Sat May 15, 2021 10:11 am 3. Once CU TIRAs are converted ROTH IRA, wait a week for confirmation from CU and then ask Fidelity to convert TIRAs for 2020 and 2021. I am assuming this can be done after Monday Tax due date.
Thank you. Just reconfirming, Do I need to conver my TIRAS for 2020 on or before May 17,2021? Or can I do it later also.
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retiredjg
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Re: Backdoor Roth conversion and confusion

Post by retiredjg »

boglemtgt wrote: Sat May 15, 2021 4:59 pm
boglemtgt wrote: Sat May 15, 2021 10:11 am 3. Once CU TIRAs are converted ROTH IRA, wait a week for confirmation from CU and then ask Fidelity to convert TIRAs for 2020 and 2021. I am assuming this can be done after Monday Tax due date.
Thank you. Just reconfirming, Do I need to conver my TIRAS for 2020 on or before May 17,2021? Or can I do it later also.
There is no deadline for converting the tIRAs. Any conversion done in 2021 will be taxed with 2021 tax return. However, I suggest that you do it soon because any earnings will be taxable. The longer you wait, the more earnings (most of the time).
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boglemtgt
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Re: Backdoor Roth conversion and confusion

Post by boglemtgt »

My CU replied with the following


4.) As far as what I can discuss from the taxable implications, it is important to know if that you are under 59.5 years old, then the act of removing the funds from the TRAD plan is considered an "early" withdrawal by the Internal Revenue Service and is usually subject to some sort of penalty or fee (assessed by the IRS on your tax return, it is not assessed or calculated by CU). Again, it is strongly recommended to consult with a local tax professional in your region to determine if doing the a ROTH conversion is the best fit for you.

#4 is what is puzzling to me. How is that considered "early" withdrawl. Let me explain, if Fidelity can do a backdoor roth IRA conversion means funds in TIRA can be converted to Roth IRA without "early" withdrawl penalty, can't CU be able to do that? I am a novice, may be asking silly questions.

To put simply how to avoid "early" withdrawil penalty and what are my options. Please let me know
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boglemtgt
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Re: Backdoor Roth conversion and confusion

Post by boglemtgt »

boglemtgt wrote: Mon May 17, 2021 10:05 am My CU replied with the following


4.) As far as what I can discuss from the taxable implications, it is important to know if that you are under 59.5 years old, then the act of removing the funds from the TRAD plan is considered an "early" withdrawal by the Internal Revenue Service and is usually subject to some sort of penalty or fee (assessed by the IRS on your tax return, it is not assessed or calculated by CU). Again, it is strongly recommended to consult with a local tax professional in your region to determine if doing the a ROTH conversion is the best fit for you.

#4 is what is puzzling to me. How is that considered "early" withdrawl. Let me explain, if Fidelity can do a backdoor roth IRA conversion means funds in TIRA can be converted to Roth IRA without "early" withdrawl penalty, can't CU be able to do that? I am a novice, may be asking silly questions.

To put simply how to avoid "early" withdrawil penalty and what are my options. Please let me know
I am planning to transfer my CU TRAD IRA CDs to Fidelity SEP401K. This way I think it will not trigger a "early withdrawl" event and no tax implications. Right? Appreciate if you can please confirm.
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retiredjg
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Re: Backdoor Roth conversion and confusion

Post by retiredjg »

boglemtgt wrote: Mon May 17, 2021 10:05 am My CU replied with the following


4.) As far as what I can discuss from the taxable implications, it is important to know if that you are under 59.5 years old, then the act of removing the funds from the TRAD plan is considered an "early" withdrawal by the Internal Revenue Service and is usually subject to some sort of penalty or fee (assessed by the IRS on your tax return, it is not assessed or calculated by CU). Again, it is strongly recommended to consult with a local tax professional in your region to determine if doing the a ROTH conversion is the best fit for you.

#4 is what is puzzling to me. How is that considered "early" withdrawl. Let me explain, if Fidelity can do a backdoor roth IRA conversion means funds in TIRA can be converted to Roth IRA without "early" withdrawl penalty, can't CU be able to do that? I am a novice, may be asking silly questions.

To put simply how to avoid "early" withdrawil penalty and what are my options. Please let me know
We don't know what question you asked to elicit this response. The response is accurate. If you take the money out, there will be an early withdrawal penalty.

If you do a rollover to some other kind of IRA, there is no early withdrawal penalty.

But...see below.
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retiredjg
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Re: Backdoor Roth conversion and confusion

Post by retiredjg »

boglemtgt wrote: Mon May 17, 2021 2:07 pm I am planning to transfer my CU TRAD IRA CDs to Fidelity SEP401K. This way I think it will not trigger a "early withdrawl" event and no tax implications. Right? Appreciate if you can please confirm.
We hear about SEP 401k very infrequently around here. Are you sure that is what you have? Are you sure it is not a SEP IRA?

If it is a 401k, moving the old CU IRAs to the 401k will not trigger an early withdrawal and it will not cost taxes. I would guess you will have an early withdrawal penalty from the CD itself (not keeping the CD until 2026).

Did you ask the credit union if you can "convert the IRAs to Roth IRA"? That would seem preferable to me. Paying tax on $5k is usually not that much.
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boglemtgt
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Re: Backdoor Roth conversion and confusion

Post by boglemtgt »

retiredjg wrote: Mon May 17, 2021 2:16 pm
If you do a rollover to some other kind of IRA, there is no early withdrawal penalty.

But...see below.
Thank you. I am planning to transfer my CU TRAD IRA CDs to Fidelity SEP401K. This way I think it will not trigger a "early withdrawl" event and no tax implications. Right? Appreciate if you can please confirm.
little_star
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Re: Backdoor Roth conversion and confusion

Post by little_star »

boglemtgt wrote: Mon May 17, 2021 10:05 am My CU replied with the following


4.) As far as what I can discuss from the taxable implications, it is important to know if that you are under 59.5 years old, then the act of removing the funds from the TRAD plan is considered an "early" withdrawal by the Internal Revenue Service and is usually subject to some sort of penalty or fee (assessed by the IRS on your tax return, it is not assessed or calculated by CU). Again, it is strongly recommended to consult with a local tax professional in your region to determine if doing the a ROTH conversion is the best fit for you.

#4 is what is puzzling to me. How is that considered "early" withdrawl. Let me explain, if Fidelity can do a backdoor roth IRA conversion means funds in TIRA can be converted to Roth IRA without "early" withdrawl penalty, can't CU be able to do that? I am a novice, may be asking silly questions.

To put simply how to avoid "early" withdrawil penalty and what are my options. Please let me know
A conversion from traditional to Roth is a taxable event. If you choose to have taxes withheld at the time of conversion, this is considered a withdrawal and will be subject to the early withdrawal penalty if you are under 59.5 years old at the time of the withholding.

The above response seems to assume that you will pay the taxes on the conversion by having them withheld. This would be bad for you not only due to the potential IRS penalty, but they would also be pulling those funds from your existing CDs, presumably requiring the return of interest (or whatever penalty is associated with breaking the CD). You should re-ask your question to the Credit Union with the specific information that you do not want the taxes withheld during the conversion.
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Re: Backdoor Roth conversion and confusion

Post by FactualFran »

boglemtgt wrote: Mon May 17, 2021 2:07 pm
I am planning to transfer my CU TRAD IRA CDs to Fidelity SEP401K. This way I think it will not trigger a "early withdrawl" event and no tax implications. Right? Appreciate if you can please confirm.
Rolling over the traditional IRA from the CU to Fidelity could trigger an early withdrawal penalty on the CD.

In an earlier post you indicated that you needed to check with the IRA processing team at the CU about whether you can do a Roth conversion. Did they say that you can do a Roth conversion at the CU? Presumably that conversion would not trigger an early withdrawal penalty on the CD.

With that conversion you want to specify that the CU is to not withhold income tax. You want to use other money to pay the income tax.
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boglemtgt
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Re: Backdoor Roth conversion and confusion

Post by boglemtgt »

FactualFran:
Please see the following post #3.
retiredjg wrote: Fri May 14, 2021 3:09 pm You only have 3 choices that I can think of.

1. Convert the old IRA to Roth and pay tax on that $5k. And convert the two new contributions to Roth.

2. Don't convert the old IRA and do convert the new contributions - and pro-rate the conversion. I don't suggest this.

3. Transfer the old IRA to a 401k or similar plan so that it is no longer in tIRA to avoid the pro-rating.

In my opinion, option #1 is a no brainer.

I guess there is a 4th option - have your 2020 and 2021 contributions returned to you as if they never happened and don't use the backdoor method to contribute to Roth IRA.
Per #3 I thought rolling over the traditiona IRA into 401K would not trigger an "early withdrawl". Is that not right?

As regards to the coversion by my CU they have indicated it would trigger "early withdrawl" I did not check tax withholding optin which you suggested. But checking if rolling over to SEP401K is an option.
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boglemtgt
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Re: Backdoor Roth conversion and confusion

Post by boglemtgt »

retiredjg wrote: Mon May 17, 2021 2:20 pm We hear about SEP 401k very infrequently around here. Are you sure that is what you have? Are you sure it is not a SEP IRA?

If it is a 401k, moving the old CU IRAs to the 401k will not trigger an early withdrawal and it will not cost taxes. I would guess you will have an early withdrawal penalty from the CD itself (not keeping the CD until 2026).

Did you ask the credit union if you can "convert the IRAs to Roth IRA"? That would seem preferable to me. Paying tax on $5k is usually not that much.
Yes it Self-employed 401K ( SEP401K).
FactualFran
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Re: Backdoor Roth conversion and confusion

Post by FactualFran »

boglemtgt wrote: Mon May 17, 2021 3:16 pm Per #3 I thought rolling over the traditiona IRA into 401K would not trigger an "early withdrawl". Is that not right?

As regards to the coversion by my CU they have indicated it would trigger "early withdrawl" I did not check tax withholding optin which you suggested. But checking if rolling over to SEP401K is an option.
Rolling over from an IRA at a CU that contains a CD of the CU to another IRA custodian could trigger an early withdrawal penalty charged by the CU. Another term for this is early redemption penalty. That penalty would reduce the dollar balance of the IRA. If the rollover is done correctly, then there will be no early distribution penalty charged by the IRS.

Check with the 401(k) trustee about whether your 401(k) accepts rollovers, and if they do, ask whether you can initiate the rollover with them (rather than initiating the rollover with the CU).
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FiveK
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Re: Backdoor Roth conversion and confusion

Post by FiveK »

boglemtgt wrote: Mon May 17, 2021 10:05 am My CU replied with the following


4.) As far as what I can discuss from the taxable implications, it is important to know if that you are under 59.5 years old
Are you under age 59.5?

The usual appellation is Solo 401(k) instead of SEP401k.
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retiredjg
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Re: Backdoor Roth conversion and confusion

Post by retiredjg »

boglemtgt wrote: Mon May 17, 2021 3:43 pm Yes it Self-employed 401K ( SEP401K).
As far as I can tell, there is no such thing as SEP 401k. There is a SEP IRA though. It is critical to know which one you have because rolling the money from the CDs to SEP IRA will not solve your problem.



There are two different kinds of early withdrawal penalty being discussed here. Be sure you understand which is being discussed.
  • There can be an early withdrawal penalty from the IRS if you take money from an IRA before age 59.5.

    There can also be an early withdrawal penalty from the bank for cashing in your CD before its due date.


I think you and the bank have miscommunicated in some way. The bank has told you there can be an early withdrawal penalty for taking money out of the tIRA if you are not old enough. And that is correct.

However, nobody is suggesting that you do that. People are suggesting that you do a "Roth conversion" on the tIRAs - meaning convert the tIRAs to Roth IRA. There will be tax due on about $5k but no early withdrawal penalty from the IRS because you are moving the money from one kind of retirement account to another type of retirement account.
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boglemtgt
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Re: Backdoor Roth conversion and confusion

Post by boglemtgt »

retiredjg wrote: Tue May 18, 2021 7:08 am As far as I can tell, there is no such thing as SEP 401k. There is a SEP IRA though. It is critical to know which one you have because rolling the money from the CDs to SEP IRA will not solve your problem.
This for sure it is SEP401K. Here is what I have https://www.fidelity.com/retirement-ira ... k/overview
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Re: Backdoor Roth conversion and confusion

Post by nolesrule »

boglemtgt wrote: Tue May 18, 2021 8:03 am
retiredjg wrote: Tue May 18, 2021 7:08 am As far as I can tell, there is no such thing as SEP 401k. There is a SEP IRA though. It is critical to know which one you have because rolling the money from the CDs to SEP IRA will not solve your problem.
This for sure it is SEP401K. Here is what I have https://www.fidelity.com/retirement-ira ... k/overview
It's not referred to as a SEP401k. Common terminology used by the various brokers that provide the service would be Solo 401k, Individual 401k (i401k) or Self Employed 401k (SE 401k).

SEP is a type of IRA.

At the link you provided a page find for "SEP" only returns the nav result in the "SEP IRA" link.
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boglemtgt
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Re: Backdoor Roth conversion and confusion

Post by boglemtgt »

nolesrule wrote: Tue May 18, 2021 9:20 am
boglemtgt wrote: Tue May 18, 2021 8:03 am
retiredjg wrote: Tue May 18, 2021 7:08 am As far as I can tell, there is no such thing as SEP 401k. There is a SEP IRA though. It is critical to know which one you have because rolling the money from the CDs to SEP IRA will not solve your problem.
This for sure it is SEP401K. Here is what I have https://www.fidelity.com/retirement-ira ... k/overview
It's not referred to as a SEP401k. Common terminology used by the various brokers that provide the service would be Solo 401k, Individual 401k (i401k) or Self Employed 401k (SE 401k).

SEP is a type of IRA.

At the link you provided a page find for "SEP" only returns the nav result in the "SEP IRA" link.
Okay my bad. its what I meant anyway. Thanks
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retiredjg
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Re: Backdoor Roth conversion and confusion

Post by retiredjg »

boglemtgt wrote: Tue May 18, 2021 9:53 am Okay my bad. its what I meant anyway. Thanks
Please forgive us for the nit pick. :(

There are some terms about investing that are very specific and must be used correctly or people will tell you to do things you should not do. Sometimes it really matters (as in this case) so sometimes some of us can be very nit picky.
FactualFran
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Re: Backdoor Roth conversion and confusion

Post by FactualFran »

It is important to confirm that the 401(k) plan will accept the rollover. Some plans accept a rollover from an IRA only if the IRA is a conduit IRA, that is, the contributions made to the IRA were only by a rollover from a qualified employer plan, such as a 40(k). See viewtopic.php?p=3356961#p3356961 for the experiences someone had a few years ago when trying to rollover to a 401(k) at Fidelity.
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boglemtgt
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Re: Backdoor Roth conversion and confusion

Post by boglemtgt »

Update:
1. My CU has converted my TRAD IRA CDs to the ROTH money market. Being the pandemic year, they were kind enough to not take out the little interest they were giving. :happy .
2. Now my next step is to convert my Fidelity Trad IRAs to Backdoor ROTH. I have contributed for the 2020 Trad IRA before the tax cut-off date and 2021 too. Now I can convert them.

My plan is t bring the ROTH MM from CU to the Fidelity ROTH account and hopefully put in some investments. I am not an aggressive type of investor. So please let me know if you have any suggestions on how I can move forward.
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FiveK
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Re: Backdoor Roth conversion and confusion

Post by FiveK »

boglemtgt wrote: Tue May 25, 2021 2:35 pm My plan is t bring the ROTH MM from CU to the Fidelity ROTH account and hopefully put in some investments. I am not an aggressive type of investor. So please let me know if you have any suggestions on how I can move forward.
The Tax-efficient fund placement - Bogleheads wiki article, including links therein, may be worth considering.
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